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61185804 Financial Management

61185804 Financial Management

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Financial Management
Unit - IIntroduction:
Financial Management is that managerial activity which is concerned with the planning and
controlling of the firm‟s financial resources.
Financial management is a process of identification, accumulation,analysis, preparation, interpretation and communication of financial information to plan, evaluate and control abusiness firm. Financial management is a specialized function of general management which is related to theprocurement of finance and its effective usage for the achievement of the goals of an organization. It wasbranch of economics till 1890, and as separate discipline it is of recent origin still, the theoretical concepts aredrawn from economics.
Finance can be defined as the art and science of managing money. Finance is concerned with theprocess, institutions, markets and instruments involved in the transfer of money among individuals, businessand government.Financial Management is the process of decision making and controlling business operations.
Western Bringham
Nature and scope of Financial Management:
Financial Management as an academic discipline has undergone fundamental changes with regard to its scopeand coverage. In the earlier years, it was treated synonymously with the raising of funds. In the later years, itsbroader scope, included in addition to the procurement of funds, efficient use of resources.Firms create manufacturing capacities for production of goods; they sell their goods or services to earn profit.They raise funds to acquire manufacturing and other facilities. The three most important activities of a businessfirm are:-
FinanceA firm secures whatever sources it needs and employs it in activities which generate returns on invested capital.
Real and financial assets:
A firm requires real assets to carry on its business. Tangible real assets are physicalassets that include plant, machinery, office, factory, furniture, and building. Intangible real assets are technicalknow how, technological collaboration, patents and copyrights. Financial assets include shares, bonds anddebentures.
Equity and borrowed Funds:
There are two types of funds that a firm can raise: Equity funds and borrowedfunds. A firm sells shares to acquire equity funds. Share holders invest their money in the shares of a companyin the expectation of a return on their invested capital. The return of share holders consists of dividend.Another important source of securing capital is creditors or lenders. Loans are generally furnished for aspecified period at a fixed rate of interest. For lenders, the return on loans comes in the form of interest paid bythe firm.Financial management is broadly concerned with the acquisition and use of funds by a business firm. The
important tasks
of financial management are,1. Financial analysis, planning and controla) Analysis of financial conditionb) Profit planningc) Financial forecastingd) Financial control2. Investinga) Management of current assets
b) Capital budgetingc) Managing of mergers, reorganizations and divestments3. Financinga) Identification of sources of finance and determination of financing mixb) Cultivating sources of funds and raising funds.c) Allocation of profits
Evolution of Financial Management:
The need for formation of large scale business enterprises and consolidation movements in the early stages of the 20
century gave rise to the emerg
ence of „financial management‟ as a distinct field of study.
It was branchof economics till 1890, and as separate discipline it is of recent origin still, the theoretical concepts are drawnfrom economics.During the initial stages of the evolution of financial management, more focus was placed on the study of sources and different forms of financing business enterprises. Business enterprises faced difficulties in raising
finance from banks and other financial institutions in 1930‟s due to economic recessi
on. Hence, the areas suchas sound financial structure and liquidity position of the firm were emphasized. New methods of planning andcontrol were concerned. The ways and means for assessing the credit worthiness of the firms were developed.The consequences of World War II facilitated the business enterprises to adopt sound financial structure and
reorganization. In the early 50‟s emphasis was laid upon liquidity and day to day operations of the firm rather 
than on profitability and institutional finance. Therefore the extent of financial management was broadened toinclude the process of decision making within the firm.
The modern phase began in the mid 1950‟s, and the concept of financial management became more analytical
and qualitative, wi
th the application of economic theories and quantitative methods of finance analysis. 1960‟switnessed phenomenal advances in the theory of „portfolio analysis‟. CAPM (capital asset pricing model) wasdeveloped in 1970‟s, which suggested that investment in
diversified portfolio of securities can neutralize the
risks faced in financial investments. In 1980‟s taxation policies in personal and corporate finance played a vitalrole. During this period the „option pricing theory‟ was also developed. Globalizatio
n of markets led to the
emergence of „Financial Engineering‟ which involves formation of optimal solutions to problems confronted in
corporate finance
Financing Functions:
The functions of raising funds investing them in assets and distributing returns earned from assets toshareholders are respectively known as financing decision, investment decision and dividend decision. A firmattempts to balance cash inflows and outflows while performing these functions. This is called liquiditydecision.-
Long term asset mix or Investment decision-
Capital mix or Financing decision-
Profit allocation or Divided decision-
Short term asset mix or Liquidity decisionA firm performs finance functions simultaneously and continuously in the normal course of the business.Finan
ce functions call for skillful planning, control and execution of a firm‟s activity.
Investment decision:
A firm investment decision involves capital expenditures. They are referred as capitalbudgeting decisions. A capital budgeting decision involves the decision of allocation of capital and also theevaluating of the prospective profitability of new investment. Future benefits of investments are difficult tomeasure and cannot be predicted with certainty. Risk in investment arises because of the uncertain returns.
Hence, investment proposals are to be evaluated in terms of both expected return and risk. Capital budgetingalso involves replacement decisions.
Financing decision:
Financing decision is the second important function in finance department. It is to decide,where from and how to acquire funds to meet the firms investment needs. The central issue here is to determine
the appropriate proportion of equity and debt. The mix of debt and equity is known as the firm‟s capitalstructure. The firm‟s capital structure is considered optimum when the market value of shares is maximized.
Dividend decision:
Dividend decision is the third major financial decision. The finance manager has to decidein what proportion the firm has to distribute the dividends. The proportion of profits distributed as dividends iscalled the dividend payout ration and retained portion of the profits is known as the retention ratio. The
optimum dividend policy is one that maximizes the market value of the firm‟s shares.
Liquidity decision:
Investment in current assets affects the firm‟s profitability and liquidity. Current assets
management that affects a firm
s liquidity is yet another important finance function. Current assets should bemanaged efficiently for safeguarding the firm against the risk of illiquidity. Lack of liquidity in extreme
situations can lead to the firm‟s insolvenc
y. A high rate of investment in current assets would provide liquiditybut it would lose profitability. As, the current assets would not earn anything thus, profitability
liquiditytradeoff must be maintained.Finance functions are said to influence production, marketing and other functions of the firm. Hence, financefunctions may affect the size, growth, profitability and risk of the firm and ultimately value of the firm.
Role of a Financial Manager:
A financial manager is a person who is responsible, in a significant way, to carry out the finance functions. Itshould be noted that, the financial manager occupies a key position. Finance managers functions not confined topreparing, maintaining records and raising funds when needed. He is now responsible for shaping fortunes of the enterprise, and is involved in the most vital decision of the allocation of capital. He needs to have broaderoutlook and must ensure the funds of the enterprise are utilized in the most efficient manner.The main functions of financial manager are,Funds raising: During the major events, such as promotion, reorganization, expansion or diversification in thefirm that the financial manager was called upon to raise funds.Funds allocation: A number of economic and environmental factors, such as the increasing pace of industrialization, technological innovations, intense competition, increasing intervention of government onaccount of management inefficiency and failure, have necessitated efficient and effective utilization of financialresources. The development of a number of management skills and decision-making techniques facilitated the
implementation of a system of optimum allocation of firm‟s resources. As a result, the emphasis shifted from
raising of funds to efficient and effective use of funds.Profit planning: The functions of the financial manager may be broadened to include profit planning function.Profit planning refers to the operating decisions in the area of pricing costs, volume of output and the f 
selection of product lines. Profit planning is a prerequisite for optimizing investment and financing decisions.Understanding capital markets: Capital markets bring investors and firms together. Hence, the financialmanager has to deal with capital markets. He should understand the operations of capital markets and the way inwhich it values the securities. He should also know how risk is measured and how to cope up with the risk ininvestment and financing decisions.

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